Around the World with Munis:
The international investment community is starting to catch onto the value and importance of the US municipal markets. The idea of using locally backed debt to fund projects is not new in many parts of the world. What is new to many international investors is the need for income as negative and near zero yields still exist in many parts of the world. As these investors search for yield, they are learning more about the US muni market, and they like what they see, even though they do not enjoy the tax-exempt benefits. They like its credit quality, positive income, and an active market of new and old bonds, and regulatory agencies that help with disclosure and policing transactions. Many of these things are missing from other local debt markets around the world. US Municipal assets held by foreigners has gone from $29 billion in 2005, to $72 billion in 2010, to an estimated $90 billion by the second quarter 0f 2016, and the inflows continue. We strongly urge the current administration to look at using taxable munis to finance its anticipated fiscal plan to stimulate infrastructure projects. If these foreign investors had the ability to invest in good quality taxable munis, their involvement would be substantial. Bring back BAB’s and let the international community finance our new roads, bridges and schools!
I had the good fortune recently to be involved in an event that gave me a chance to learn more about municipal bonds in other parts of the world. I thought I would share this experience with our investors and let them know how blessed we are as USA municipal bond buyers. FYI – Don’t worry, MainLine West is not going to be change its name to MainLine International.
Munis in the United Kingdom:
Market Size: 2013 estimate local borrowing at 84.5 billion pounds ($105 billion USD)
Current Market Structure:
- Limited access, expensive, limited to larger municipalities and not locally controlled.
- 75% of municipals are issued through the Public Works Loan Board, which is a statutory body of the UK Government that provides loans to local authorities. Currently, all projects are funded from the central government, no matter how urgent projects may be. Politics are a big factor in what gets done, and how quickly, which usually leaves the little local governments without much access. The rate to be paid by the local government is set by the Public Works Loans Board.
Future Market Developments:
- The recent introduction of a new, independent third party designed to improve access, lower cost and provide local control – UK Municipal Bond Agency (UKMBA).
- In 2015, the UKMBA was formed to act like a bond bank, pool issuers together and enjoy benefits of economies of scale. This should help the little local governments gain access. UKMBA would also help bridge issuers and buyers to create a more active market. It is anticipated that the UKMBA will improve credit quality and lower borrowing costs.
- UKMBA is owned by the local councils and local government associations. They appear to have 6 million pounds in capital. Pool Issue sizes are anticipated to be 250 to 300 million pounds and made up of 30 to 40 borrowers.
- London banks appear interested in investing in more local debt as a way to diversify their portfolios.
- Proceeds of the bonds will help localities fund their infrastructure needs. First issuance was scheduled for the fall of 2016, but, at this point, it has been delayed. Original target date was March/April 2015.
Conclusions:
It appears the UK muni market is still trying to get itself up and running. A lot of planning and time has gone into it, but it has yet to take its first big step. Brexit may have slowed it up this time, but I think, longer term, this will help the market and we will see the UKMBA become a player.
Munis in Sweden:
Market Size: 240 billion Krona market ($30 billion USA)
Current Market Structure:
- Kommuninvest – A Swedish local government funding agency set up in 1986 has issued and backed over half of the muni bonds in Sweden. It helps local governments Issue bonds and has enough capital to back the deals to allow them to have a AAA rating. The market appears to be limited to larger issuers, but at least they have control over their projects and funding needs.
Future Market Developments:
- Looking at allowing banks to buy munis as liquidity on Government debt is drying up and has no yield. The banks would earn close to 2% and provide a boost to the economy via more projects. This is not popular with some issuers, as they fear the banks will crowd out natural buyers.
- The market has been growing, up 84% over the last three years.
Conclusions:
It appears Sweden is trying to find ways to increase the use of municipal bonds to fund needed infrastructure projects. The monopoly that Kommuninvest has on the market remains a concern, as it does not sound like there are any other 3rd parties looking to step in.
Munis in Africa
Market Size: ? – None?
Current Market Structure:
- The data is limited on the African municipal market. There have been bond issues that were scheduled, but never made it to market. Zambia tried in 2013/2014, but was unable to borrow the funds needed.
- Most recently (1/15/15) Dakar, the capital of Senegal, was finally able to issue $40 million in USD at a 6.60% .
African cities are facing a shortfall in urban financing, and municipal bonds are being viewed as a way to plug the finance gap. A big headwind is the inability for municipalities to issue debt directly. There are concerns on the investor’s side to trust revenue streams needed to pay the debt off, and disclosure on financial matters.
Future Market Developments:
- It looks like it will be a struggle for any type of municipal market to develop in Africa anytime soon. African nations are most in need of local spending, but lack of revenue sources, and good governance impair the development of a market. Even major cities such as Johannesburg have been unable to raise capital. The experience of Dakar is quite impressive, but success in the bond market remains limited.
- At this moment, it appears the use of private resources are the best way to fund infrastructure projects. This is the case with developing markets, as infrastructure investments require some form of credit enhancement, or concessions to get the funds needed. The World Bank is currently looking at ways to assist in this process.
Conclusions:
It is hard to see a municipal market developing in Africa. Political risk, lack of a true market system in any aspects, and regulatory control concerns are just too big of obstacles. Unfortunately, Africa would have the most to gain if one did develop.
Munis in China:
Market Size: It is unknown how much “shadow debt” really exists in China and how much of this can be converted to publically owned debt. If the Central Government is successful in developing the market the way it wants to, it is forecast that it could create the second largest municipal market in the world at $1.5 trillion (USD) .
Current Market Structure:
- Once completely bank controlled, China started in 2015 the process of privatizing its municipal bond sector and making it a market driven one. This involves auditing the local governments, taking loans off the “shadow” banking system and providing liquidity to sell bonds in the market.
- The large local governments (example Beijing) have been first to go through this process. It is believed to be moving this debt to the market, it will help ease the strain on the banking system, provide reduced borrowing costs, and better financial disclosure.
Future Market Developments:
- As the sector becomes more market driven, issuers are hoping to receive more autonomy to do what they want with their borrowings. They will also be able to issue bonds with maturities of 5, 7 and 10 years. In the past they were limited to just 7 years.
- China is hoping its municipal market will entice foreign and local investors. To do so, they will need to improve financial disclosure, impose debt limits on the issuers, and get the US rating agencies to rate the localities . There remains a lot of concern by oversea investors about the quality of the issuers, their ability to access revenue, and just how much debt is still in the shadows.
- Yields appear to be enticing at 3% to 4% for issuers that are able to come to market.
Conclusions:
Expect this market to continue to grow and it could be a new “hot” investment vehicle for investors. The Central Government appears to be strongly in support as they see it as a way to solve several of their biggest economic problems, 1) ease debt burdens and fiscal concerns for their “shadow” banking system, 2) keep money and hopefully attract more into the country to keep funding growth, 3) provide capital for the large infrastructure needs of the country. The Central Government has also allowed debt holders to use the munis as collateral, which has encouraged investment by local banks and companies. Foreign investors are interested in getting involved, as yields are just too enticing given levels in the rest of the fixed income world.
We caution anyone looking to get into Chinese munis. Disclosure is the key, and there needs to be a lot of improvement before these securities can be sold to Main Street. There will most likely be some problems along the way. There appears to be opportunities for those who know what they are doing, but also potential bankruptcies for those who don’t.
Muni’s Around the World?
There you have it, a glimpse at other municipal markets around the world. Makes you want to say, “God Bless the USA Municipal Bond Market!”